Supply and Demand in Businesses

Topics: Supply and demand, Consumer theory, Elasticity Pages: 6 (1048 words) Published: May 31, 2014
1. Compute the elasticities for each independent variable. Note: Write down all of your calculations.

When P = 500, C = 600, I = 5500, A = 10000 and M = 5000, using regression equation,  
QD = -5200 - 42*500 + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000 = 17650  
Price elasticity = (P/Q)*(dQ/dP)
 
From regression equation, dQ/dP = -42.
 
So, price elasticity EP= (P/Q) * (-42) = (-42) * (500 / 17650) = -1.19  
Likewise,
 
EC = 20 * 600 / 17650 = 0.68
 
EI = 5.2 * 5500 / 17650 = 1.62
 
EA = 0.20 * 10000 / 17650 = 0.11
 
EM = 0.25 * 5000 / 17650 = 0.07

2. Determine the implications for each of the computed elasticities for the business in terms of short-term and long-term pricing strategies. Provide a rationale in which you cite your results.  Price elasticity is -1.19.  This indicates a 1% increase in the price of the product, which results the quantity demanded to drop by 1.19%.  Therefore, the demand of this product is somewhat elastic. Subsequently, increase in price may drive customers away.  

Cross-price elasticity is 0.68.  If  the price of a competitor’s product goes up by 1%, then quantity demanded of this product will increase by 0.68%.   This product is fairly inelastic to a competitor’s price and there is no need to be concerned about the competitor since their pricing won’t affect sales. Income-elasticity is 1.62.  This indicates that a 1% rise in the average area income will boost the quantity demanded by 1.62%.  In this aspect, the product is elastic and the company can make the decision to raise the price if the average income rises. Advertisement elasticity is 0.11which means that a 1% increase in advertising expenses will raise the quantity demanded by only 0.11%.  Therefore, demand is a rather inelastic to advertising. So for that reason, more advertisement doesn’t automatically mean that a company can raise the price because that still could drive customers away.  With respect to microwave ovens in the area, elasticity is 0.07, generally which shows an elevation ofa1%  in the number of ovens in the area increasing the quantity demanded by a mere 0.07%. Therefore, in such aspect, demand is inelastic and the pricing strategy can simply skip this element.  

Consequently, quantity demanded (as we have seen above) is sensitive to the price of product and the income of people but somewhat insensitive to our competitor’s price and almost completely insensitive to advertising and the amount of microwaves existing in area. 3. Recommend whether you believe that this firm should or should not cut its price to increase its market share. Provide support for your recommendation.  A cut in price would raise the quantity demanded since the price elasticity is negative. Moreover, the elasticity is a little over unity. Also revenue is maximized when the degree of elasticity is one.  With regarding that in mind, price reduction will raise the quantity demanded and will lead to a net gain in sales as elasticity moves towards unity.  In my viewpoint, the firm should decrease the price just as it would increase the market share and the revenue generated.

4. Assume that all the factors affecting demand in this model remain the same, but that the price has changed. Further assume that the price changes are 100, 200, 300, 400, 500, 600 cents.  A.  Plot the demand curve for the firm.

By means of all further factors constant, the demand equation is shown below: Q = -5200 - 42*P + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000 Q = 38650 - 42P
P = 38650/42 - Q/42 
B.        Plot the corresponding supply curve on the same graph using the supply function Q = 5200 + 45P with the same prices. Q = 5200 + 45P
P = -5200/45 + Q/45
C. Determine the equilibrium price and quantity.
After resolving the demand and supply equation alongside,
38650 - 42P = 5200 + 45P
87P = 33450
P = 384.48
and Q = 5200 + 45*384.48 = 22501
 
Therefore, the equilibrium price is 384 cents & the equilibrium quantity is 22,501...

References: Bruno, M., & Sachs, J. D. (1979). Supply vs. demand approaches to the problem of stagflation.
Blanchard, O. J., &Quah, D. (1990).The dynamic effects of aggregate demand and supply disturbances.
Campbell, J. Y., &Viceira, L. M. (2002). Strategic asset allocation: portfolio choice for long-term investor.
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